Legacy Wealth Weekly - May 27, 2016 (Climbing a Wall of Worry)

Penni Johnston-gill - May 27, 2016

Despite much uncertainty with regard to OPEC, the Fed and the UK referendum (“Brexit”) in June, both the S&P/TSX (~1.3%) and the S&P 500 (~2.0%) continued their march forward this week. In fact, when these concerns are mixed with massive inflows into

Weekly Market Wrap-Up: Climbing a Wall of Worry

Despite much uncertainty with regard to OPEC, the Fed and the UK referendum (“Brexit”) in June, both the S&P/TSX (~1.3%) and the S&P 500 (~2.0%) continued their march forward this week. In fact, when these concerns are mixed with massive inflows into bearish ETFs, reduced equity exposure by hedge funds, large outflows from equity mutual funds and multi-year lows in investors’ bullishness, the net result is a nice wall of worry investors can climb to power stock markets higher. Interestingly, although probabilities of a summer Fed hike rose again this week, the more volatile areas of the stock market such as the NASDAQ and Russell 2000 indexes led the market. This dynamic could indicate that investors feel more comfortable with the Fed turning the screws in response to better US economic data which should translate into improved earnings-growth performance in 2016. In Canada, the S&P/TSX has cleared the 14K resistance. Despite the strong rally YTD, we learned this week that short interest on Canadian stocks has barely budged. This pent-up demand represents huge marginal buying power.

Our focus this week is on various leading economic indicators (LEIs) of world economic growth, namely the JPM world PMI composite, the IFO index, the OECD LEI and world M1 growth. As our Chart of the Week shows, these four proxies of global growth conditions are trending up since January, likely signaling the end of the global manufacturing recession and a pickup in global economic activity in the second half. At a time when portfolio investors are still wondering whether the rally in cyclical stocks will continue or peter out like through last summer, this is much welcome news. Obviously, much of the durability of the anticipated recovery could depend upon the Fed’s monetary bias which dictates the US$ direction, and by ricochet, global financial conditions. Beyond its “two-hike” game plan for the year, we believe the Fed should maintain a dovish bias until the world economy (especially EMs) is strong enough to absorb a stronger US$. Otherwise, all bets are off.

Regarding economic data this week, in Canada, the BoC left its benchmark rate unchanged at 0.5% saying that business investment and capex intentions remain disappointing. Meanwhile, “household vulnerabilities have moved higher” but a strong US labour market and weak CDN$ are both beneficial to the Canadian economy. In the US, new home sales blew off expectations with a 16.6% MoM print (vs. 2% exp.) and the FHFA home price inflation accelerated to 6.1% (from 5.6%). Other good news came from durable goods orders progressing 3.4% MoM. Unfortunately, the advance was the result of soaring orders in nondefense aircraft and parts (+65%). Nondefense capital goods orders excluding aircraft provide a more sobering outlook, down 0.8% MoM. In Europe, the flash Markit mfg. PMI dropped slightly to 51.5 (from 51.7) while the service PMI came in unchanged at 53.1. This seems consistent with the drop in the ZEW economic sentiment index (16.8 from 21.5). Elsewhere, in Japan, exports further worsened, down 10.1% YoY (from -6.8%) and imports cratered, declining 23.3% in April (from -14.9%). Adding to the mix a flash PMI at 47.6 (from 48.2) and increased deflationary pressures with May inflation coming in at -0.5% YoY (from -0.3%), it seems the BoJ is running out of options and may have to delay next year's planned VAT increase.

Next week, we await the OPEC meeting and final PMI releases globally. In Canada, Q1/16 GDP growth and the current account are on deck. In the US, personal income/spending as well as PCE inflation should help gauge the Fed’s intention. Last, in Europe, we will watch inflation and loan growth.

For next week, we will focus on global flash PMI releases, the BoC interest rate decision, US durable goods orders and new home sales. Finally, we await the trade balance and inflation in Japan.

The Canaccord Genuity research included in the Legacy Wealth Weekly is solely for Canadian residents. To subscribe to our weekly newsletter, click here.